Austerity and Its Discontents

After a period of pushback, proponents of austerity are retaking the intellectual high ground and promoting responsible budgeting throughout the developed world.

BRUSSELS, BELGIUM — Perched on a knoll rising gently above a man-made pond in Brussels’s stunning Parc Leopold sits the stately five-story granite building that once housed Europe’s first parliament. Years ago, that legislature began splitting time between Strasbourg, Luxembourg, and a sleek new building in Brussels.

The migration of the EU parliament is a fitting metaphor for a fast-moving trend that has taken hold on the Continent in the wake of its collapsing economies: the imposition of, and now the attempt to roll back, a series of measures to trim spending that Europeans often label, in a derogatory fashion, “austerity.” But after a period of pushback, pro-austerity forces are gaining strength by promoting responsible budgeting throughout the developed world.

Austerity, often known in the United States as “fiscal responsibility,” has stirred a heated academic and policy debate on both sides of the Atlantic. As austerity has been imposed by the European Union on the wayward, debt-laden countries on its periphery, in part on the basis of scholarly studies demonstrating its importance, many of those countries have bristled at its restrictions, as have left-leaning economists worldwide.

Academic Debate on the Reinhart-Rogoff Study

The academic argument has been fascinating. In a landmark 2010 paper, Carmen Reinhart and Kenneth Rogoff, Harvard professors and economists at the National Bureau of Economic Research, identified a relationship between high levels of debt and economic growth: “median growth rates for countries with public debt over roughly 90 percent of GDP are about 1 percent lower than otherwise.” The median growth rate for countries they observed having debt levels ranging from 60 to 90 percent of GDP was around 2.8 percent. That rate declined to 1.9 percent for countries with debt-to-GDP levels exceeding 90 percent. The findings were based on hundreds of years of economic data from some 44 countries spanning 3,700 annual observations.

But earlier this year, three economists from the University of Massachusetts at Amherst —Thomas Herndon, Michael Ash, and Robert Pollin — published a blistering attack on Reinhart and Rogoff’s work. They noted a coding error in the Harvard economists’ spreadsheet that inadvertently omitted data from the first five alphabetical countries in their survey, namely Australia, Austria, Belgium, Canada, and Denmark. The critics also claimed that “unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and growth among these 20 advanced economies in the post-war period.” They lambasted Reinhart and Rogoff’s decision to selectively exclude certain data.

Even with all the adjustments, Reinhart and Rogoff’s conclusion remains basically the same.

In response, Reinhart and Rogoff publishederrata earlier this month in which they thanked the UMass economists “for the careful attention and for pointing out an important correction” to the original paper — that is, the omission of the five “A through D” countries, data for which they now include, along with other adjusted data. They also adjusted their data to add hitherto conflicting but now-reconciled GDP numbers for Spain between 1959 and 1980, as well as to include and correct certain figures for New Zealand.

Yet even with all the adjustments, Reinhart and Rogoff’s conclusion remains basically the same: based on updated, 2013 numbers, median post-war GDP growth has fallen from 2.8 percent at a debt-to-GDP ratio between 60 and 90, to 1.8 percent (just 0.1 percent off the original paper’s number) once the ratio surpasses 90.

Reinhart and Rogoff also responded sensibly to the UMass criticism about their “selective exclusion” and weighting of numbers.

Others have criticized Reinhart and Rogoff for positing, without justification, a causal relationship between high debt and low growth. And, indeed, it can be hard to say whether excessive debt thwarts growth, whether a slowing economy spurs debt, or both. Indeed, the Harvard researchers acknowledge this, consistently taking care in their papers to note that high debt is “associated with” low growth; Rogoff forthrightly stated in a 2012 article that “of course, there is two-way feedback between debt and growth.”

In addition, as the Harvard economists observe in their errata, “numerous other papers have contributed to this literature since our original paper in 2010 and have also addressed issues pertaining to the direction of causality between debt and growth, debt thresholds and nonlinearities, as well as examining post-war samples different from ours in the 2010 paper.”

But at least in the recent cases of exploding debt in Greece and Cyprus, among others, it’s easy to see why stifling levels of debt tend to bring economic growth to a screeching halt. As investors justifiably flee fiscal basket case countries, credit freezes up, and businesses simply cannot grow.

Austerity and Politics

But this debate has proven more than just academic, as advocates of fiscal responsibility have seized Reinhart and Rogoff’s mantle, while Keynesians have sought to tear it asunder, aided by the UMass folks.

House Budget Committee Chairman Paul Ryan (R-WI) cited the Harvard professors’ findings in his proposed 2013 budget: “A well-known study completed by economists Ken Rogoff and Carmen Reinhart confirms this common-sense conclusion. The study found conclusive empirical evidence that gross debt (meaning all debt that a government owes, including debt held in government trust funds) exceeding 90 percent of the economy has a significant negative effect on economic growth.”

And beginning with the 2008 global financial meltdown, followed in 2010 by fiscal collapses or near-collapses in Portugal, Italy, Ireland, Greece, and Spain, the European Union imposed significant budgetary restrictions on the peripheral PIIGS countries.

Olli Rehn, vice president of the European Commission and the EU’s economic commissioner, used the Reinhart-Rogoff study as one basis, among others, for pushing austerity measures. “It is widely acknowledged,” Rehn wrote in an April letter to Europe’s finance ministers, “based on serious academic research, that when public debt levels rise above 90 percent they tend to have a negative impact on economic dynamism, which translates into low growth for many years. That is why consistent and carefully calibrated fiscal consolidation remains necessary in Europe.”

While some pro-Reinhart-Rogoff economists have questioned whether the shock treatment on the periphery has been too extreme — the pair themselves wrote in the New York Times in April that “our consistent advice has been to avoid withdrawing fiscal stimulus too quickly, a position identical to that of most mainstream economists” — many policymakers have drawn inspiration from at least some of their conclusions.

Political Pushback

Yet recently, many Europeans — aided by pro-stimulus Keynesians — have grown tired of the slow growth they attribute to austerity, and their voices have grown in number and volume. “Merkel pressed to ease up on austerity,” blared one late April Financial Times headline of the German chancellor who famously favors fiscal responsibility. “Eurozone anti-austerity camp on the rise,” screamed another, co-authored by a Brussels-based correspondent who laid the blame squarely on Reinhart and Rogoff’s shoulders.

“Flaws found last week,” Peter Spiegel and Peter Ehrlich wrote in the FT, “in an academic treatise on the effect of high public debt on economic growth have heaped pressure on governments to relax austerity, above all in crisis-stricken Europe, long seen as an incubator for austerity-driven policies.” Apparently, what happens in the Ivory Tower doesn’t always stay in the Ivory Tower.

Some of the countries who have endured the sharpest cuts have recently pushed hard for relief from the conditions imposed by the Europeans in exchange for their bailout. After writing down some €100 billion in debt last year, Greece has appealed to the Europeans for more relief, and a decision is apparently imminent. Ireland and Portugal are also seeking additional time to repay outstanding loans. And Japan’s Keynesian prime minister, Shinzo Abe, recently announced plans for a 10.3 trillion yen ($103 billion) stimulus package.

The Harvard economists’ rebuttal has begun to allow the advocates of fiscal responsibility in Europe and the United States to gain the upper hand.

This hysteria regarding austerity reached a fever pitch in early May, when an Oxford sociologist and a Stanford epidemiologist claimed in a New York Times article entitled “How Austerity Killed” that “countries that slashed health and social protection budgets, like Greece, Italy and Spain, have seen starkly worse health outcomes than nations” that didn’t. Indeed, the researchers posited, “austerity — severe, immediate, and indiscriminate cuts to social and health spending — is not only self-defeating, but fatal.” Yet this is confusing correlation and causation. Sadly, we should expect poor health outcomes in countries whose fiscal condition has deteriorated so badly that the government can’t pay its own bills, let alone take care of its ailing citizens.

Back in the real world, the Harvard economists’ rebuttal has begun to allow the advocates of fiscal responsibility in Europe and the United States to gain the upper hand. The Germans, for one, aren’t backing down on austerity. “There’s no need for a special fiscal stimulus program,” Michael Hüther, director of the Cologne Institute for Economic Research, told the New York Times last week. Jens Wiedmann, president of Germany’s central bank, criticized his French counterparts earlier this month for failing to bring their own budget into line. “That isn’t saving, by my reckoning,” Weidmann said of French President Francois Hollande’s halting attempts to cut his country’s deficit to 3 percent of GDP this fiscal year (it will actually come in around 3.9 percent).

Mario Draghi, president of the European Central Bank, declared earlier this month that “governments should not unravel efforts” at budget-cutting and continued to urge “fiscal consolidation based on reductions of current expenditures, rather than tax increases.” In general, one New York Times business columnist reckoned last week, “despite all this intellectual firepower [for further stimulus], governments across the industrial world are zealously tightening their belts,” noting that Italy “has cut its annual budget deficit to 3 percent of G.D.P. last year from 5.5 percent in 2009, and the Irish government has slashed it to 7.6 percent from 13.9 percent.”

Finally, as the American Enterprise Institute’s James Pethokoukis has pointed out, the U.S. economy has outperformed Europe’s despite our predilection for even more austerity than our continental friends. Sure enough, as government spending falls and the private sector picks up the slack, our economy has slowly begun to take flight.

As even former Treasury secretary and Harvard president Larry Summers — no fan of the Reinhart and Rogoff thesis — put it recently, “It is a grave mistake to suppose that debt can or should be accumulated with abandon … further action will be necessary almost everywhere in the industrial world to ensure that debt levels are sustainable after economies recover.”

Michael M. Rosen, a contributor to THE AMERICAN, is an attorney and writer in San Diego.